Foreign Exchange Reserves and Its Alternative Uses: Policy Prescription for India

Abstract

The unprecedented surge in foreign exchange reserves (hereafter reserves) recently in the Asian economies has raised a concern for holding optimum reserves and its alternative uses. The objective of this paper is to identify the adequate and excess reserves, and to analyze the alternative possible ways for investing these excess reserves. Reserve adequacy has been explained by various ratio measures, and then excess reserves have been estimated based on basic thumb rules. The alternative use of excess reserves has been analyzed with the international experiences after discussing India's recent trend of utilizing its reserves. The ratio analysis suggests India has been accumulating excess reserves after meeting the basic economic needs. It is observed that, the major portion of India's reserves is invested in securities and showing an increasing trend. The portfolio of deposits with the other central banks has declined in recent years and diverted to investment in securities and deposits with foreign commercial banks. The analysis from cross-country experiences show that countries have broadly diversified their reserves into four basic portfolios: liquidity portfolio, investment portfolio, immunization portfolio and the oil revenue fund portfolio. India can follow these countries experiences and institute a special corporation for managing its growing reserves in various alternative channels like investment in financial institutions, real estate, new energy, stocks, and bonds and also in infrastructure development for enhancing economic growth and for efficient diversification of reserve portfolios.